Returns On Capital At Adrad Holdings (ASX:AHL) Paint A Concerning Picture

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Adrad Holdings (ASX:AHL), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Adrad Holdings, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.073 = AU$12m ÷ (AU$190m - AU$29m) (Based on the trailing twelve months to June 2023).

So, Adrad Holdings has an ROCE of 7.3%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 11%.

Check out our latest analysis for Adrad Holdings

Above you can see how the current ROCE for Adrad Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Adrad Holdings.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Adrad Holdings, we didn't gain much confidence. Around two years ago the returns on capital were 17%, but since then they've fallen to 7.3%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Adrad Holdings has decreased its current liabilities to 15% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Adrad Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Adrad Holdings is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 30% over the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

On a separate note, we've found 2 warning signs for Adrad Holdings you'll probably want to know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.